Forward Agreement Spread: Understanding the Basics
Forward Agreement Spread, also known as FAS, is a popular trading strategy used in the energy market. It is a derivative financial contract which allows parties to lock in the price difference between two different delivery periods. FAS is an agreement between the buyer and seller of energy, usually crude oil, natural gas, or electricity, to buy or sell at a future date.
In FAS, the price is determined based on the difference between the forward price of the near-term contract and the far-term contract. The difference between the prices is called the “spread,” and the parties involved agree on the spread amount. This spread can either be positive or negative, and it is used to hedge against price volatility.
There are two types of FAS: calendar spread and quality spread. The calendar spread involves the buying and selling of futures contracts of different calendar months, while the quality spread involves the buying and selling of futures contracts of different qualities. For instance, a crude oil FAS can be based on the difference between Brent and WTI crude oil.
FAS has several advantages for energy traders. It provides them with a way to hedge against market volatility by locking in a fixed spread. This makes it easier for them to manage risks and plan their trading strategies. FAS also enables traders to benefit from market inefficiencies and price disparities between different contracts.
However, FAS is not without its risks. It requires traders to have a clear understanding of the energy market and an accurate prediction of future price movements. This makes the strategy more suitable for experienced traders who have a good understanding of the market.
In conclusion, Forward Agreement Spread is a popular trading strategy used in the energy market. It allows parties to lock in the price difference between two different delivery periods and provides traders with a way to hedge against price volatility. However, it requires a clear understanding of the market and an accurate prediction of future price movements. FAS is a useful tool for experienced traders who are looking to manage risks and benefit from market inefficiencies.